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Taxation of Cryptocurrency

Last Updated November 22, 2021

Cryptocurrency, or virtual currency, has become an increasingly important economic force in recent years, both in the United States and around the world. Using blockchain technology, it turns complex digital information into real world currency, which can be used without validation from a third-party clearinghouse, such as a bank. For this reason, it’s known as a decentralized or peer-to-peer monetary system. The data is then encrypted, protecting its ownership and use from outside forces or unauthorized persons.

Bloomberg Tax analyzes all aspects of cryptocurrency taxation regulations and provides expert guidance to help you navigates the complex nuances of cryptocurrency tax law at the federal, international, and state levels.

What is the IRS’ guidance on the taxation of virtual currency?

In March 2014, the IRS published Notice 2014-21. As a threshold matter, the IRS analyzed whether a cryptocurrency should be classified as a currency or property for U.S. income tax purposes. In general, a “virtual currency” is defined as a “digital representations of value that functions as a medium of exchange, a unit of account, and/or a store of value.” A convertible virtual currency is defined as a sub-category of a virtual currency or one “that has an equivalent value in real currency, or that acts as a substitute for real currency.”

As the cryptocurrency landscape changes, so will taxation related to cryptocurrency. In October 2019, five years following the publication of Notice 2014-21, the IRS released Rev. Rul. 2019-24 and a list of Frequently Asked Questions on Virtual Currency Transactions to which the IRS adds additional guidance episodically.

Rev. Rul. 2019-24 addresses two scenarios unique to distributed ledger technology, including a scenario in which a hard fork occurs and the taxpayer receives no new cryptocurrency and a scenario in which a hard fork occurs and the taxpayer receives units of a new cryptocurrency as a result of an airdrop.

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How are virtual currencies taxed?

Virtual currency is treated as property for federal income tax purposes. General tax principles applicable to property transactions apply to transactions using virtual currency. Therefore, the rules applicable to foreign currency transactions under subpart J are not applicable and thus virtual currencies cannot generate foreign currency gain or loss for U.S. federal income tax purposes.

A taxpayer who receives virtual currency as a payment for goods or services must include in its gross income the fair market value of the virtual currency measured in U.S. dollars, as of the date that virtual currency was received. Furthermore, the basis of virtual currency a taxpayer receives as payment for goods or services is the fair market value of the virtual currency in U.S. dollars as of the date of the receipt.

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Subscriber-only: Portfolio 190: Taxation of Cryptocurrencies 

This portfolio considers the federal income tax laws of the virtual currency known as Bitcoin.

How are capital gains and losses from virtual currencies tracked?

If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain.  Similarly, the taxpayer recognizes loss if the fair market value of the property received is less than the adjusted basis of the virtual currency.

The IRS has not addressed how to track the computation of capital gains and losses (basis and fair market value) in the context of “convertible” virtual currencies. Some practitioners have suggested to simplify the burdensome record-keeping requirements that are necessary to calculate virtual currency gains and losses by applying §1012 tracking methods under FIFO, LIFO, or the specific identification method akin to the way stocks are sold through an exchange.

In addition, practitioners have suggested that the IRS should provide a de-minimis rule for taxpayers who may have a minimal amounts of virtual currency transactions or small transactions (e.g., purchasing coffee).

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Federal vs. state vs. international cryptocurrency laws

At the federal level, virtual currency is considered property and taxed as such. At the state level, however, cryptocurrency taxation brings with it another important consideration: sales tax. Is the sale of virtual currency subject to local sales tax? Most states, in fact, as yet have no guidance or legislation on the subject. Of the few states that do, some, such as California and Kentucky, treat crypto as equivalent to cash in transactions, and tax it according to the same standard. In other states, such as Arkansas and Kansas, digital currencies aren’t subject to taxes.

There is also very little guidance on whether owners of cryptocurrency need to fulfill international reporting requirements. It’s generally recognized that U.S. citizens, residents, and others subject to U.S. tax laws, must file a Foreign Bank Account Report for any financial account outside the U.S. whose maximum value exceeds $10,000 at any point during the previous calendar year. However, it’s unclear as to whether or not these financial interests include virtual currency.

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Cryptocurrency Tax Laws by State

Get a complete state-by-state breakdown of cryptocurrency tax laws at a glance.

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Tax Practice Guide

This practice guide addresses issues practitioners may face in transacting with cryptocurrencies, including reporting requirements.

Portfolio 190-1st: Taxation of Cryptocurrencies 

This portfolio considers the federal income tax laws of the virtual currency known as Bitcoin.

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